No Credibility

Let's get one thing straight:  the Fed has no credibility on inflation.  There are many out there who believe that the Fed will keep hiking until they break something but they don't have the balls for that.  Or the courage to take the economic pain to lower inflation.  Already, you are hearing a Fed governor talk about a pause in September with CPI at 8.2%!  These guys are more scared of a hard landing disinflationary environment with tight financial conditions than they are of a slow burn high inflation environment with easy financial conditions.  

They are scarecrows.  They talk a tough game, but don't play a tough game.  And they are so late, that they are early.  What that means is that they are so late to tighten, that they've missed their rate hiking window as the bubble economy has peaked out.  And that makes their current rate path and balance sheet well suited to a downturn.  They now won't have to hike as much as priced into the market because the economy is already weakening.  Thus, since they never went to a restrictive policy rate, they don't have to ease right away and look weak on inflation, because they never tightened enough in the first place.  Instead of having a 2+% Fed funds rate from early 2021 to early 2023, like they should have, they will instead have a 2+% Fed funds rate from mid 2022 to early 2023, so 18 months less of tight financial conditions, and then they will gleefully cut from 2+% down to zero when facing a growth scare in 2023/2024.  

So Powell will have managed to do a lot of talking, with very little action and with only a brief period of rates at a "neutral" rate, before going back to the default easy money policy and zero rates at the first hint of slowing growth, regardless of inflation.  The bond market is already starting to sniff this out as the Eurodollars market is getting inverted in 2023, with Jan 2024 Eurodollars priced higher than Jan 2023 eurodollars, basically meaning that STIRs markets are forecasting rate cuts in 2023.  

What does this mean for markets for the next 12 months?  It means that you won't get the capitulation that everyone is looking for because the Fed will try to steer this plane away from a hard landing, by not getting financial conditions tight enough.  In the process, inflation will remain higher, commodities prices will keep going higher, and the dollar will go lower.  The yield curve will steepen, as short term rates go down and long term rates less so as the Fed tolerates a higher inflation environment.  Stocks will be the trickiest part because stocks love a Fed that doesn't tighten financial conditions, but at the same time, you have a massive overweight in US stocks among both US and foreign investors, high valuations, and corporate margins under pressure from higher labor costs.  

The federal government spending will still be quite stimulative in 2023, so if the Fed steps off the gas, you probably have a range bound market with slightly lower highs and lows for the next 12 months.  This is assuming what I think Powell will do, which is raise 50 bps at the next 2 meetings, taking Fed funds up to 1.75-2.00%, and maybe doing 1 or 2 hikes of 25 bps in Sep/Oct/Dec, and then saying job is done, congratulating himself for "fighting inflation" and having an appropriate rate for the current economy, which the market will love, and you probably get a 2-3 month rally, and then everyone will look around and see that inflation is still high, and the economy still sucks, and then the markets will have another Wylie Coyote moment as another waterfall decline emerges from the complacency.  This will get Powell panicked and looking for ways to placate a market having a temper tantrum because he's not cutting rates and rates are still above 2%.  Powell will then go into bazooka/hero ball mode, cutting like hell down to zero.  

This market is all Fed all the time, so that's the only thing that matters.  Earnings are just a distraction.  The meme of this bubble era is the Fed, so they are the drivers of all short to intermediate term moves.  Long term moves are driven by valuations, which are still not favorable here.  

With a spineless Fed, you will not see capitulation for quite a while, so don't bet on it for 2022.  Inflation/commodity prices stay high, although base effects/additional CPI manipulation will help to lower the CPI number which will be a convenient excuse for the Fed to pat themselves on the back and talk about how their measly few rate hikes and tough talk are working, even when they aren't. 

Its a choppy market, no V bottoms, lots of time spent lingering near the lows.  This is a continuing theme for 2022.  Rallies don't last for more than 1 or 2 days.  The margin for error is much narrower for bulls, and much wider for bears.  This is the mirror image from 2009 to 2021.  Trade accordingly.  

The high put/call ratios support the case for a short term tradable bounce, but the fund flows data / COT futures positioning data shows investors stubbornly holding on to overweight equity long positions.  Maybe a few weeks of sideways trade from 3800 to 4100 and then a steady grind move down towards 3600 in the late summer to force the Fed's hand into pausing at the September FOMC meeting.